Democrat Tax Proposals For Retirement Accounts Will Affect More Than The Wealthy

By Garth Friesen, Contributor
WASHINGTON, DC - SEPTEMBER 14: U.S. Rep. Mike Kelly (R-PA) speaks during a markup hearing at Longworth House Office Building September 14, 2021 on Capitol Hill in Washington, DC. House Ways And Means Committee continued its markup on a third day for the Democrats' $3.5 trillion spending package. (Photo by Alex Wong/Getty Images) Getty Images

House Democrats proposed sweeping changes to retirement accounts on Monday as part of a restructuring of the tax code designed to target the wealthy. Some make sense. Others need to be scrapped.

The suggested changes are intended to limit the dollar value of assets held in IRA accounts. Specifically, the House Ways and Means Committee proposal:

  • Prohibits new contributions if IRA balances exceed $10 million
  • Eliminates “backdoor” and “mega backdoor” Roth IRA rollovers
  • Disallows IRA investments in entities in which the owner has a substantial interest
  • Increases minimum required distributions for high-income taxpayers with large IRA balances and introduces mandatory distributions for Roth IRAs
  • Disallows IRA investments that require the owner to have accredited investor status

Most people won’t argue about limiting contributions from the uber-rich to tax-advantaged accounts. But why target investors with accredited investor status? The exact wording is as follows:

“The bill prohibits an IRA from holding any security if the issuer of the security requires the IRA owner to have certain minimum level of assets or income, or have completed a minimum level of education or obtained a specific license or credential. For example, the legislation prohibits IRAs from holding investments which are offered to accredited investors because those investments are securities that have not been registered under federal securities laws. IRAs holding such investments would lose their IRA status. This section generally takes effect for tax years beginning after December 31, 2021, but there is a 2-year transition period for IRAs already holding these investments.”

Current requirements for accredited investor designation are primarily based on financial status. For most individual investors to qualify, they need an annual income of $200,000 (or $300,000 combined with their spouse) or a net worth (including their spouse’s net worth but excluding the value of their primary residence) of $1 million. Not poor, by any means, but certainly not the mega-rich.

Most alternative investments, such as private lending, hedge funds and private equity, can only be sold to people who are deemed accredited. The rule would therefore prevent IRAs from holding these types of investments. This would limit investor access to certain assets when many are aggressively seeking alternatives to the traditional “60/40” stock/bond portfolio.

The SEC is probably not a fan of the proposed limitations. In fact, it recently modified the definition of an accreditor investor to allow more, not less, access to alternative investments.

The SEC memo states:

“These amendments are part of the Commission’s ongoing effort to simplify, harmonize, and improve the exempt offering framework, thereby expanding investment opportunities while maintaining appropriate investor protections and promoting capital formation.”

The final rule goes on to say:

“The main anticipated benefit to investors from the final amendments is access to a broader investment opportunity set that can potentially improve the risk-return characteristics of their portfolios.”

More than two million taxpayers report holding unconventional assets in their IRA and there are tens of millions of people with accredited investor status. Why go after the doctor who makes $300,000/year with a $25,000 investment in a crowdfunded farm in Idaho? The bill was not supposed to impact anybody making less than $400,000, yet restricting IRA investments that require accredited investor status will affect more than the super-wealthy.

The proposed legislation would remove the tax benefits of an IRA if a position in a prohibited investment were not addressed within a “2-year transition period.” What does that mean? What if the investment is still present in a traditional IRA after the 2-year transition? Would an investor have to sell existing positions? Many alternative investments have limited or no liquidity. What if there is no secondary market for the investment? We still don’t know.

What amendments should be made?

At a minimum, the rule should grandfather existing IRAs with alternative investments. A better suggestion would be to scrap any linkage to investor status altogether. The legislation would prevent the situation where a knowledgeable person can stuff a Roth IRA with undervalued, illiquid shares of private, controlled investments like Peter Thiel did when he turned a $2,000 Roth IRA into more than $5 billion. Let’s face it: that is not going to happen for the majority of us.

Investors should be able to access alternative investments wherever they want. Limiting investment choices for the average investor was not supposed to be one of the goals of the budget. Messing with existing IRAs is ill-advised.

Limiting closely held private shares in an IRA? Go for it. Prohibiting Roth conversions in certain circumstances? Fine. Attacking and punishing IRAs that own perfectly suitable, diversified pools of alternative assets that help them meet their retirement goals? That’s going too far.

Let’s hope financial advisors and investors make their concerns known before the final bill is written. Financial planners will tell you IRAs are critical to those saving for retirement. Restricting the types of investments that can go into these accounts is not going to raise more tax dollars – it is going to limit the ability of millions of people to diversify their investment portfolios.


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